Attached files
file | filename |
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EX-32 - EXHIBIT 32 - INNOVATE Corp. | a2016-q3form10xqexhibit32.htm |
EX-31.2 - EXHIBIT 31.2 - INNOVATE Corp. | a2016-q3form10xqexhibit312.htm |
EX-31.1 - EXHIBIT 31.1 - INNOVATE Corp. | a2016-q3form10xqexhibit311.htm |
EX-10.5 - EXHIBIT 10.5 - INNOVATE Corp. | a10_5hc2-preferredconversi.htm |
EX-10.4 - EXHIBIT 10.4 - INNOVATE Corp. | a10_4hc2-preferredconversi.htm |
EX-10.3 - EXHIBIT 10.3 - INNOVATE Corp. | a10_3hc2-preferredconversi.htm |
EX-10.2 - EXHIBIT 10.2 - INNOVATE Corp. | a10_2hc2-preferredconversi.htm |
EX-10.1 - EXHIBIT 10.1 - INNOVATE Corp. | a10_1indemnificationagreem.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________________________________________________________________________
FORM 10-Q
_________________________________________________________________________________________
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended September 30, 2016
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
Commission File No. 001-35210
_________________________________________________________________________________________
HC2 HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
_________________________________________________________________________________________
Delaware | 54-1708481 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
450 Park Avenue, 30th Floor | ||
New York, NY | 10022 | |
(Address of principal executive offices) | (Zip Code) |
(212) 235-2690
(Registrant’s telephone number, including area code)
______________________________________________________________
______________________________________________________________
Former name or former address, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x |
Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding as of October 31, 2016 |
Common Stock, $0.001 par value | 41,818,944 |
HC2 HOLDINGS, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION | ||||
PART II. OTHER INFORMATION | ||||
2
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Services revenue | $ | 245,064 | $ | 151,933 | $ | 624,545 | $ | 373,492 | ||||||||
Sales revenue | 133,474 | 125,534 | 379,729 | 386,765 | ||||||||||||
Life, accident and health earned premiums, net | 19,967 | — | 59,939 | — | ||||||||||||
Net investment income | 14,799 | — | 42,585 | — | ||||||||||||
Net realized losses on investments | (220 | ) | — | (2,677 | ) | — | ||||||||||
Net revenue | 413,084 | 277,467 | 1,104,121 | 760,257 | ||||||||||||
Operating expenses | ||||||||||||||||
Cost of revenue - services | 225,876 | 138,099 | 583,942 | 334,608 | ||||||||||||
Cost of revenue - sales | 107,984 | 102,395 | 308,951 | 324,820 | ||||||||||||
Policy benefits, changes in reserves, and commissions | 29,689 | — | 92,784 | — | ||||||||||||
Selling, general and administrative | 36,902 | 28,810 | 107,493 | 77,818 | ||||||||||||
Depreciation and amortization | 5,961 | 6,267 | 18,163 | 17,768 | ||||||||||||
Gain on sale or disposal of assets | (23 | ) | (1,106 | ) | (973 | ) | (135 | ) | ||||||||
Lease termination costs | (159 | ) | 1,124 | 179 | 1,124 | |||||||||||
Total operating expenses | 406,230 | 275,589 | 1,110,539 | 756,003 | ||||||||||||
Income (loss) from operations | 6,854 | 1,878 | (6,418 | ) | 4,254 | |||||||||||
Interest expense | (10,719 | ) | (10,383 | ) | (31,614 | ) | (29,208 | ) | ||||||||
Other income (expense), net | (3,203 | ) | 1,193 | (4,220 | ) | (1,378 | ) | |||||||||
Income from equity investees | 335 | 918 | 3,153 | 427 | ||||||||||||
Loss from continuing operations before income taxes | (6,733 | ) | (6,394 | ) | (39,099 | ) | (25,905 | ) | ||||||||
Income tax benefit (expense) | 1,334 | (1,504 | ) | 3,649 | 1,832 | |||||||||||
Loss from continuing operations | (5,399 | ) | (7,898 | ) | (35,450 | ) | (24,073 | ) | ||||||||
Loss from discontinued operations | — | (24 | ) | — | (44 | ) | ||||||||||
Net loss | (5,399 | ) | (7,922 | ) | (35,450 | ) | (24,117 | ) | ||||||||
Less: Net (income) loss attributable to noncontrolling interest and redeemable noncontrolling interest | 841 | (65 | ) | 2,365 | (8 | ) | ||||||||||
Net loss attributable to HC2 Holdings, Inc. | (4,558 | ) | (7,987 | ) | (33,085 | ) | (24,125 | ) | ||||||||
Less: Preferred stock and deemed dividends | 2,948 | 1,035 | 5,061 | 3,212 | ||||||||||||
Net loss attributable to common stock and participating preferred stockholders | $ | (7,506 | ) | $ | (9,022 | ) | $ | (38,146 | ) | $ | (27,337 | ) | ||||
Basic loss per common share: | ||||||||||||||||
Loss from continuing operations | $ | (0.20 | ) | $ | (0.35 | ) | $ | (1.07 | ) | $ | (1.09 | ) | ||||
Loss from discontinued operations | — | — | — | — | ||||||||||||
Basic and diluted loss per common share | $ | (0.20 | ) | $ | (0.35 | ) | $ | (1.07 | ) | $ | (1.09 | ) | ||||
Diluted loss per common share: | ||||||||||||||||
Loss from continuing operations | $ | (0.20 | ) | $ | (0.35 | ) | $ | (1.07 | ) | $ | (1.09 | ) | ||||
Loss from discontinued operations | — | — | — | — | ||||||||||||
Net loss attributable to common stock and participating preferred stockholders | $ | (0.20 | ) | $ | (0.35 | ) | $ | (1.07 | ) | $ | (1.09 | ) | ||||
Weighted average common shares outstanding: | ||||||||||||||||
Basic | 36,627 | 25,592 | 35,808 | 25,093 | ||||||||||||
Diluted | 36,627 | 25,592 | 35,808 | 25,093 |
3
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net loss | $ | (5,399 | ) | $ | (7,922 | ) | $ | (35,450 | ) | $ | (24,117 | ) | ||||
Other comprehensive income (loss) | ||||||||||||||||
Foreign currency translation adjustment | 672 | (5,275 | ) | 1,335 | (7,147 | ) | ||||||||||
Unrealized gain (loss) on available-for-sale securities, net of tax | 8,972 | (2,008 | ) | 71,261 | (4,186 | ) | ||||||||||
Less: Comprehensive (income) loss attributable to the noncontrolling interest and redeemable noncontrolling interest | 841 | (65 | ) | 2,365 | (8 | ) | ||||||||||
Comprehensive income (loss) attributable to HC2 Holdings, Inc. | $ | 5,086 | $ | (15,270 | ) | $ | 39,511 | $ | (35,458 | ) |
See accompanying notes to Condensed Consolidated Financial Statements.
4
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(Unaudited)
September 30, 2016 | December 31, 2015 | |||||||
Assets | ||||||||
Investments: | ||||||||
Fixed maturity securities, available-for-sale at fair value | $ | 1,331,677 | $ | 1,231,841 | ||||
Equity securities, available-for-sale at fair value | 56,506 | 49,682 | ||||||
Mortgage loans | 8,939 | 1,252 | ||||||
Policy loans | 18,228 | 18,476 | ||||||
Other invested assets | 60,870 | 53,119 | ||||||
Total investments | 1,476,220 | 1,354,370 | ||||||
Cash and cash equivalents | 121,321 | 158,624 | ||||||
Restricted cash | 791 | 538 | ||||||
Accounts receivable (net of allowance for doubtful accounts of $3,033 and $794 at September 30, 2016 and December 31, 2015, respectively) | 272,738 | 210,853 | ||||||
Costs and recognized earnings in excess of billings on uncompleted contracts | 17,091 | 39,310 | ||||||
Inventory | 8,973 | 12,120 | ||||||
Recoverable from reinsurers | 525,599 | 522,562 | ||||||
Accrued investment income | 15,751 | 15,300 | ||||||
Deferred tax asset | 43,555 | 52,511 | ||||||
Property, plant and equipment, net | 244,176 | 214,466 | ||||||
Goodwill | 86,025 | 61,178 | ||||||
Intangibles, net | 39,144 | 29,409 | ||||||
Other assets | 35,520 | 65,206 | ||||||
Assets held for sale | 1,093 | 6,065 | ||||||
Total assets | $ | 2,887,997 | $ | 2,742,512 | ||||
Liabilities, temporary equity and stockholders’ equity | ||||||||
Life, accident and health reserves | $ | 1,637,501 | $ | 1,591,937 | ||||
Annuity reserves | 254,250 | 260,853 | ||||||
Value of business acquired | 48,512 | 50,761 | ||||||
Accounts payable and other current liabilities | 232,149 | 225,389 | ||||||
Billings in excess of costs and recognized earnings on uncompleted contracts | 51,241 | 21,201 | ||||||
Deferred tax liability | 12,807 | 4,281 | ||||||
Long-term obligations | 396,688 | 371,876 | ||||||
Pension liability | 20,744 | 25,156 | ||||||
Other liabilities | 12,042 | 17,793 | ||||||
Total liabilities | 2,665,934 | 2,569,247 | ||||||
Commitments and contingencies | ||||||||
Temporary equity: | ||||||||
Preferred stock, $.001 par value - 20,000,000 shares authorized; Series A - 27,308 and 29,172 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively; Series A-1 - 1,000 and 10,000 shares issued and outstanding at September 30, 2016 and December 31, 2015; Series A-2 - 14,000 shares issued and outstanding at September 30, 2016 and December 31, 2015 | 41,659 | 52,619 | ||||||
Redeemable noncontrolling interest | 1,993 | 3,122 | ||||||
Total temporary equity | 43,652 | 55,741 | ||||||
Stockholders’ equity: | ||||||||
Common stock, $.001 par value - 80,000,000 shares authorized; 38,263,606 and 35,281,375 shares issued and 38,031,325 and 35,249,749 shares outstanding at September 30, 2016 and December 31, 2015, respectively | 38 | 35 | ||||||
Additional paid-in capital | 228,842 | 209,477 | ||||||
Accumulated deficit | (112,814 | ) | (79,729 | ) | ||||
Treasury stock, at cost | (1,262 | ) | (378 | ) | ||||
Accumulated other comprehensive gain (loss) | 37,221 | (35,375 | ) | |||||
Total HC2 Holdings, Inc. stockholders’ equity before noncontrolling interest | 152,025 | 94,030 | ||||||
Noncontrolling interest | 26,386 | 23,494 | ||||||
Total stockholders’ equity | 178,411 | 117,524 | ||||||
Total liabilities, temporary equity and stockholders’ equity | $ | 2,887,997 | $ | 2,742,512 |
See accompanying notes to Condensed Consolidated Financial Statements.
5
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(Unaudited)
Common Stock | Additional Paid-In Capital | Treasury Stock | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss) | Non- controlling Interest | ||||||||||||||||||||||||||
Shares | Amount | Total | |||||||||||||||||||||||||||||
Balance as of December 31, 2014 | 23,813 | $ | 24 | $ | 141,948 | $ | (378 | ) | $ | (44,164 | ) | $ | (18,243 | ) | $ | 25,208 | $ | 104,395 | |||||||||||||
Share-based compensation expense | — | — | 7,402 | — | — | — | — | 7,402 | |||||||||||||||||||||||
Dividend paid to noncontrolling interest | — | — | — | — | — | — | (1,038 | ) | (1,038 | ) | |||||||||||||||||||||
Preferred stock dividends and accretion | — | — | (3,212 | ) | — | — | — | — | (3,212 | ) | |||||||||||||||||||||
Amortization of issuance costs and beneficial conversion feature | — | — | (375 | ) | — | — | — | — | (375 | ) | |||||||||||||||||||||
Issuance of Common Stock | 5 | — | — | — | — | — | — | — | |||||||||||||||||||||||
Issuance of restricted stock | 1,539 | 2 | — | — | — | — | — | 2 | |||||||||||||||||||||||
Conversion of Preferred Stock | 235 | — | 1,000 | — | — | — | — | 1,000 | |||||||||||||||||||||||
Acquisition of controlling interest | — | — | — | — | — | — | (822 | ) | (822 | ) | |||||||||||||||||||||
Excess book value over fair value of purchased noncontrolling interest | — | — | 43 | — | — | — | (43 | ) | — | ||||||||||||||||||||||
Excess of fair value of net assets over purchase price of acquired company | — | — | 182 | — | — | — | — | 182 | |||||||||||||||||||||||
Net loss | — | — | — | — | (24,125 | ) | — | 8 | (24,117 | ) | |||||||||||||||||||||
Foreign currency translation adjustment | — | — | — | — | — | (7,147 | ) | — | (7,147 | ) | |||||||||||||||||||||
Unrealized loss on available-for-sale securities, net of tax | — | — | — | — | — | (4,186 | ) | — | (4,186 | ) | |||||||||||||||||||||
Balance as of September 30, 2015 | 25,592 | $ | 26 | $ | 146,988 | $ | (378 | ) | $ | (68,289 | ) | $ | (29,576 | ) | $ | 23,313 | $ | 72,084 |
Common Stock | Additional Paid-In Capital | Treasury Stock | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss) | Non- controlling Interest | ||||||||||||||||||||||||||
Shares | Amount | Total | |||||||||||||||||||||||||||||
Balance as of December 31, 2015 | 35,250 | $ | 35 | $ | 209,477 | $ | (378 | ) | $ | (79,729 | ) | $ | (35,375 | ) | $ | 23,494 | $ | 117,524 | |||||||||||||
Share-based compensation expense | — | — | 6,667 | — | — | — | — | 6,667 | |||||||||||||||||||||||
Fair value adjustment of Redeemable noncontrolling interest | — | — | (99 | ) | — | — | — | — | (99 | ) | |||||||||||||||||||||
Exercise of Warrants and Stock Options | 2 | — | — | — | — | — | — | — | |||||||||||||||||||||||
Shares withheld to satisfy tax withholdings | (201 | ) | — | — | (884 | ) | — | — | — | (884 | ) | ||||||||||||||||||||
Preferred stock dividend and accretion | — | — | (2,386 | ) | — | — | — | — | (2,386 | ) | |||||||||||||||||||||
Amortization of issuance costs and beneficial conversion feature | — | — | (309 | ) | — | — | — | — | (309 | ) | |||||||||||||||||||||
Issuance of common stock | 65 | — | — | — | — | — | — | — | |||||||||||||||||||||||
Issuance of restricted stock | 199 | — | — | — | — | — | — | — | |||||||||||||||||||||||
Conversion of Preferred Stock | 2,564 | 3 | 10,850 | — | — | — | — | 10,853 | |||||||||||||||||||||||
Deemed dividend to induce conversion of Preferred Stock | 152 | — | (1,490 | ) | — | — | — | — | (1,490 | ) | |||||||||||||||||||||
Acquisition of controlling interests | — | — | — | — | — | 2,161 | 2,161 | ||||||||||||||||||||||||
Sale of controlling interest | — | — | — | — | — | — | 8,000 | 8,000 | |||||||||||||||||||||||
Excess fair value over book value of noncontrolling interest sold | — | — | 6,132 | — | — | — | (6,132 | ) | — | ||||||||||||||||||||||
Net loss | — | — | — | — | (33,085 | ) | — | (2,365 | ) | (35,450 | ) | ||||||||||||||||||||
Net income attributable to redeemable noncontrolling interest | — | — | — | — | — | — | 1,228 | 1,228 | |||||||||||||||||||||||
Foreign currency translation adjustment | — | — | — | — | — | 1,335 | — | 1,335 | |||||||||||||||||||||||
Unrealized gain on available-for-sale securities, net of tax | — | — | — | — | — | 71,261 | — | 71,261 | |||||||||||||||||||||||
Balance as of September 30, 2016 | 38,031 | $ | 38 | $ | 228,842 | $ | (1,262 | ) | $ | (112,814 | ) | $ | 37,221 | $ | 26,386 | $ | 178,411 |
See accompanying notes to Condensed Consolidated Financial Statements.
6
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months Ended September 30, | |||||||
2016 | 2015 | ||||||
Cash flows from operating activities: | |||||||
Net loss | $ | (35,450 | ) | $ | (24,117 | ) | |
Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | |||||||
Provision for doubtful accounts receivable | 827 | 325 | |||||
Share-based compensation expense | 6,667 | 7,402 | |||||
Depreciation and amortization | 19,602 | 23,503 | |||||
Amortization of deferred financing costs and debt discount | 1,530 | 1,246 | |||||
Amortization of fixed maturities discount/premium | 8,966 | — | |||||
(Gain) loss on sale or disposal of assets | 251 | (135 | ) | ||||
Net realized (gains) losses on investments | 2,519 | (431 | ) | ||||
Impairment of investments | 4,321 | — | |||||
Equity investment (income) loss | (3,153 | ) | (427 | ) | |||
Lease termination costs | 179 | 1,124 | |||||
Deferred income taxes | (18,940 | ) | (5,957 | ) | |||
Receipt of dividends from equity investees | 7,214 | 2,448 | |||||
Annuity benefits | 6,737 | — | |||||
All other operating activities | (224 | ) | 315 | ||||
Changes in assets and liabilities, net of acquisitions: | |||||||
(Increase) decrease in accounts receivable | (56,463 | ) | (36,099 | ) | |||
(Increase) decrease in costs and recognized earnings in excess of billings on uncompleted contracts | 22,219 | (9,253 | ) | ||||
(Increase) decrease in inventory | 3,518 | 455 | |||||
(Increase) decrease in other assets | 26,725 | (3,316 | ) | ||||
Increase (decrease) in life, accident and health reserves | 41,942 | — | |||||
Increase (decrease) in accounts payable, current and other liabilities | (12,625 | ) | 42,364 | ||||
Increase (decrease) in billings in excess of costs and recognized earnings on uncompleted contracts | 30,040 | (21,933 | ) | ||||
Increase (decrease) in pension liability | (1,423 | ) | (8,665 | ) | |||
Net cash provided by (used in) operating activities | 54,979 | (31,151 | ) | ||||
Cash flows from investing activities: | |||||||
Purchase of property, plant and equipment | (21,689 | ) | (16,751 | ) | |||
Sale of property and equipment | 511 | 4,994 | |||||
Purchase of investments | (179,291 | ) | (41,710 | ) | |||
Sale of investments | 72,188 | 6,876 | |||||
Sale of assets held for sale | 5,900 | 1,479 | |||||
Cash paid for business acquisitions, net of cash acquired | (10,871 | ) | (568 | ) | |||
Maturities and redemptions of fixed maturity securities | 53,663 | — | |||||
Change in restricted cash | (253 | ) | (727 | ) | |||
All other investing activities | (230 | ) | — | ||||
Net cash used in investing activities | (80,072 | ) | (46,407 | ) | |||
Cash flows from financing activities: | |||||||
Proceeds from long-term obligations | 11,672 | 54,963 | |||||
Principal payments on long-term obligations | (11,441 | ) | (8,473 | ) | |||
Payment of deferred financing costs | — | (1,137 | ) | ||||
Annuity receipts | 2,522 | — | |||||
Annuity surrenders | (15,562 | ) | — |
7
Proceeds from issuance of common stock of subsidiary | 8,000 | ||||||
Proceeds from sale of preferred stock, net | — | 14,033 | |||||
Purchase of noncontrolling interest | (2,163 | ) | (239 | ) | |||
Payment of withholdings related to net settlements | (884 | ) | — | ||||
Payment of dividends | (3,007 | ) | (3,855 | ) | |||
Net cash provided by (used in) financing activities | (10,863 | ) | 55,292 | ||||
Effect of currency exchange rate changes on cash and cash equivalents | (1,347 | ) | (4,646 | ) | |||
Net change in cash and cash equivalents | (37,303 | ) | (26,912 | ) | |||
Cash and cash equivalents, beginning of period | 158,624 | 107,978 | |||||
Cash and cash equivalents, end of period | $ | 121,321 | $ | 81,066 | |||
Supplemental cash flow information: | |||||||
Cash paid for interest | $ | 21,491 | $ | 21,445 | |||
Cash paid for taxes | $ | 13,469 | $ | 1,701 | |||
Non-cash investing and financing activities: | |||||||
Purchases of property, plant and equipment under financing arrangements | $ | — | $ | 1,808 | |||
Property, plant and equipment included in accounts payable | $ | 1,542 | $ | 1,521 | |||
Fair value of contingent asset assumed in other acquisitions | $ | 2,992 | $ | — | |||
Fair value of deferred liability assumed in other acquisitions | $ | 2,589 | $ | — | |||
Debt assumed in other acquisitions | $ | 20,813 | $ | — | |||
Deemed dividend from conversion of preferred stock | $ | 1,490 | $ | — | |||
Conversion of preferred stock | $ | 10,853 | $ | 1,000 |
See accompanying notes to Condensed Consolidated Financial Statements.
8
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Business
HC2 Holdings, Inc. (“HC2” and, together with its subsidiaries, the “Company”, “we”, "us" and “our”) is a diversified holding company which seeks to acquire and grow attractive businesses that the Company believes can generate long-term sustainable free cash flow and attractive returns. While the Company generally intends to acquire controlling equity interests in its operating subsidiaries, the Company also invests to a more limited extent in a variety of debt instruments or noncontrolling equity interest positions. HC2's common stock trades on the NYSE MKT LLC under the symbol “HCHC”.
The Company currently has seven reportable segments based on management’s organization of the enterprise - Manufacturing, Marine Services, Insurance, Utilities, Telecommunications, Life Sciences, and Other which includes operations that do not meet the separately reportable segment thresholds.
1.Our Manufacturing segment includes DBM Global Inc. (“DBM Global”, f/k/a Schuff International, Inc.) and its wholly-owned subsidiaries. DBM Global offers integrated steel construction services from a single source and professional services that include design-assist, design-build, engineering, building information modeling participation, 3D steel modeling / detailing, fabrication, advanced field erection, project management and state-of-the-art steel management systems. Major market segments for DBM Global include commercial, healthcare, convention centers, stadiums, gaming and hospitality, mixed use and retail, industrial, public works, bridges, transportation, and international projects. Headquartered in Phoenix, Arizona, DBM Global has operations in Arizona, California, Georgia, Kansas, and Texas, with construction projects primarily located in the aforementioned states, in addition to international construction projects in select markets, primarily Panama, through its Panamanian joint venture Schuff Hopsa Engineering. The Company maintains a 92% controlling interest in DBM Global.
2.Our Marine Services segment includes Global Marine Systems Limited ("GMSL"). GMSL is a leading provider of engineering and underwater services on submarine cables. The Company maintains a 95% equity interest in GMSL.
3.Our Insurance segment includes United Teacher Associates Insurance Company ("UTA") and Continental General Insurance Company ("CGI", and together with UTA, the "Insurance Companies"). The Insurance Companies provide long-term care, life and annuity coverage that help protect policy and certificate holders from the financial hardships associated with illness, injury, loss of life, or income continuation. The Company owns 100% of the Insurance Companies.
4.Our Utilities segment includes American Natural Gas ("ANG"). Headquartered in the Northeast, ANG is a premier distributor of natural gas motor fuel. ANG designs, builds, owns, acquires, operates and maintains compressed natural gas fueling stations for transportation vehicles. The Company maintains effective control of, and a 49.99% ownership interest in ANG.
5.Our Telecommunications segment includes PTGi International Carrier Services, ("ICS"). ICS operates a telecommunications business including a network of direct routes and provides premium voice communication services for national telecom operators, mobile operators, wholesale carriers, prepaid operators, Voice over Internet Protocol ("VOIP") service operators and Internet service providers from our International Carrier Services business unit. ICS provides a quality service via direct routes and by forming strong relationships with carefully selected partners. The Company owns 100% of ICS.
6.Our Life Sciences segment includes Pansend Life Sciences, LLC (“Pansend”). Pansend owns a (i) 77% interest in Genovel Orthopedics, Inc., which seeks to develop products to treat early osteoarthritis of the knee, (ii) 61% interest in R2 Dermatology Incorporated (f/k/a GemDerm Aesthetics, Inc.), which develops skin lightening technology, and (iii) 80% interest in BeneVir Biopharm, Inc. ("BeneVir"), which focuses on immunotherapy for the treatment of solid tumors. Pansend also invests in other early stage or developmental stage healthcare companies.
7.In our Other segment, we invest in and grow developmental stage companies that we believe have significant growth potential. Among the businesses included in this segment are the Company's 56% ownership interest in DMi, Inc. ("DMi"), which owns licenses to create and distribute NASCAR® video games, and the Company's 72% interest in NerVve Technologies Inc. ("NerVve"), which provides analytics on broadcast TV, digital and social media online platforms.
9
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial reporting and Securities and Exchange Commission (“SEC”) regulations. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such principles and regulations. In the opinion of management, the financial statements reflect all adjustments (all of which are of a normal and recurring nature), which are necessary to present fairly the financial position, results of operations, cash flows and comprehensive income (loss) for the interim periods. The results for the Company’s nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2016. The financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in the Company’s most recently filed Annual Report on Form 10-K.
Principles of Consolidation
The Condensed Consolidated Financial Statements include the accounts of the Company, its wholly owned subsidiaries and all other subsidiaries over which the Company exerts control. All intercompany profits, transactions and balances have been eliminated in consolidation. As of September 30, 2016, the Company has a 100% interest in the Insurance Companies, a 100% interest in ICS, a 95% interest in GMSL, a 92% interest in DBM Global, a 56% interest in DMi, a 72% interest in NerVve, and board control of, and a 49.99% interest in ANG. Because the Company controls the operations of ANG through its control of the board, the assets, liabilities, revenues and expenses of ANG are included in our Condensed Consolidated Financial Statements. Through its subsidiary, Pansend, the Company has a 77% interest in Genovel Orthopedics, Inc., a 61% interest in R2 Dermatology and an 80% interest in BeneVir. The results of each of these entities are consolidated with the Company’s results from and after their respective acquisition dates based on guidance from the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”). The remaining interests not owned by the Company are presented as a noncontrolling interest component of total equity. DBM Global uses a 4-4-5 week quarterly cycle, which for the third quarter of 2016 ended on October 1, 2016.
Reclassification
Certain previous year amounts have been reclassified to conform with current year presentations related to the reporting of new financial statement line items.
Adjustments
During the second quarter of 2016, the Company identified an immaterial error in its calculation of depreciation expense for the twelve months ended December 31, 2015 and 2014 and the three months ended March 31, 2016 related to purchase accounting associated with the acquisition of DBM Global in May of 2014. This resulted in an excess depreciation expense being recorded in each of the periods noted. In addition, certain gains and losses on assets that were disposed of by DBM Global were incorrectly recorded during the same periods as a result of these adjustments. The net impact of these adjustments to net income would have been an increase of $0.7 million and a decrease of $0.2 million for the twelve months ended December 31, 2015 and 2014, respectively, and an increase of $0.8 million for the three months ended March 31, 2016.
The Company determined to correct the cumulative effect of these adjustments in the second quarter of 2016, which resulted in a net adjustment to net income (loss) attributable to common and participating preferred stockholders for the nine months ended September 30, 2016 of $1.3 million. Excluding this adjustment, net loss attributable to common and participating preferred stockholders would have been $39.4 million or $1.10 per fully diluted share for the nine months ended September 30, 2016, instead of the $38.1 million recorded.
Newly Adopted Accounting Principles
In September 2015, the FASB issued Accounting Standards Update ("ASU") 2015-16, “Business Combination Topic No. 805: Simplifying the Accounting for Measurement - Period Adjustments”, which requires adjustments to provisional amounts that are identified during the measurement period to be recognized in the reporting period in which the adjustment amounts are determined.
10
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
This includes any effect on earnings of changes in depreciation, amortization, or other income effects as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In August 2015, the FASB issued ASU 2015-15, “Interest - Imputation of Interest Subtopic No. 835-30: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements,” which codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line-of-credit arrangements as assets, rather than as a direct offset to the liability as is required now under ASU 2015-03. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In July 2015, the FASB issued ASU 2015-12, "(Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, and (Part III) Measurement Date Practical Expedient". Part I of this ASU is related to one area of several potential simplifications for employee benefit plans and designates contract value as the only required measure for fully benefit-responsive investment contracts, which maintains the relevant information while reducing the cost and complexity of reporting for fully benefit responsive investment contracts. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In May 2015, the FASB has issued ASU 2015-9, "Disclosures About Short-Duration Contracts". This ASU requires insurance entities to disclose for annual reporting periods certain information in respect of liability for unpaid claims and claim adjustment expenses. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In May 2015, the FASB issued ASU 2015-8, “Business Combinations Topic No. 805: Pushdown Accounting-Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115 (SEC Update),” which rescinds certain SEC guidance in order to conform with ASU 2014-17, “Pushdown Accounting” (“ASU 2014-17”). ASU 2014-17 was issued in November 2014 and provides a reporting entity that is a business or nonprofit activity (an “acquiree”) the option to apply pushdown accounting to its separate financial statements when an acquirer obtains control of the acquiree. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In May 2015, the FASB issued ASU 2015-07, "Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)". The amendments in this ASU remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In February 2015, the FASB issued ASU 2015-2, “Amendments to the Consolidation Analysis”, which amends the consolidation requirements in ASC 810 and significantly changes the consolidation analysis required under U.S. GAAP relating to whether or not to consolidate certain legal entities. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
In January 2015, the FASB issued ASU 2015-1, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items”, which eliminates from U.S. GAAP the concept of an extraordinary item. Under the ASU, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.
New Accounting Pronouncements
In August, 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force)" ("ASU 2016-15"). The amendments in ASU 2016-15 address eight specific cash flow issues and apply to all entities that are required to present a statement of cash flows under FASB ASC 230, "Statement of Cash Flows." The amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption during an interim period. The Company
11
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
has not yet adopted this update and is currently evaluating the impact of ASU 2016-15 on its Condensed Consolidated Financial Statements.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses" (Topic 326)" ("ASU-2016-13"), which amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, ASU 2016-13 eliminates the probable initial recognition threshold in current U.S. GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available-for-sale debt securities, credit losses should be measured in a manner similar to current U.S. GAAP, however ASU 2016-13 will require that credit losses be presented as an allowance rather than as a write-down. For public business entities that file reports with the SEC, the amendments in the ASU are effective for fiscal years beginning after December 15, 2019. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-13 on its Condensed Consolidated Financial Statements.
In May 2016, the FASB issued ASU 2016-12, "Revenue From Contracts With Customers" "(Topic 606)" ("ASU 2016-12"), which addresses narrow-scope improvements to the guidance on collectability, non-cash consideration, and completed contracts at transition. Additionally, the amendments in this update provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The effective date and transition requirements for the amendments in this update are the same as the effective date and transition requirements for ASU 2016-12 (and any other Topic amended by ASU 2014-09). "Revenue from Contracts with Customers (Topic 606), Section A - Summary and Amendments that Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs - Contracts with Customers (Subtopic 340-40)" ("ASU 2014-09"). ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-12 on its Condensed Consolidated Financial Statements.
In April 2016, the FASB issued ASU 2016-10, "Revenue From Contracts With Customers (Topic 606): Identifying Performance Obligations and Licensing" ("ASU 2016-10"), which clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in the new revenue recognition standard. Further, this update includes targeted improvements based on input the Board received from the Transition Resource Group for Revenue Recognition and other stakeholders. ASU 2016-10seeks to proactively address areas in which diversity in practice potentially could arise, as well as to reduce the cost and complexity of applying certain aspects of the guidance both at implementation and on an ongoing basis. The Company has not yet adopted ASU 2016-10 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" "(Topic 718)" ("ASU 2016-09"), which introduces targeted amendments intended to simplify accounting for stock compensation. Specifically, ASU 2016-09 requires all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) to be recognized as income tax expense or benefit in the income statement. Early adoption is permitted. The Company has not yet adopted this update and is currently evaluating the update would have on its Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU 2016-08, "Principal versus Agent Considerations" (Topic 606), which updates the new revenue standard by clarifying the principal versus agent implementation guidance. Early adoption is permitted. The Company's effective date for adoption is January 1, 2018. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-08 on its Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU 2016-07, "Simplifying the Transition to the Equity Method of Accounting" "(Topic 323)" ("ASU 2016-07"), which requires an investor to initially apply the equity method of accounting from the date such investor qualifies for that method (i.e., the date such investor obtains significant influence over the operating and financial policies of an investee). The ASU eliminates the previous requirement to retroactively adjust the investment and record a cumulative catch up for the periods that the investment had been held, but did not qualify for the equity method of accounting. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-07 on its Condensed Consolidated Financial Statements.
12
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In March 2016, the FASB issued ASU 2016-06, "Contingent Put and Call Options in Debt Instruments" "(Topic 815)" ("ASU 2016-06"), which addresses how an entity should assess whether contingent call or put options that can accelerate the payment of debt instruments are clearly and closely related to their debt hosts. This assessment is necessary to determine if the option(s) must be separately accounted for as a derivative. ASU 2016-06 clarifies that an entity is required to assess the embedded call or put options in accordance with a specific four-step decision sequence. This means that entities are not also required to assess whether the contingency for exercising the option(s) is indexed to interest rates or credit risk. For example, when evaluating debt instruments that may be put upon a change in control, the event triggering the change in control is not relevant to the assessment. Only the resulting settlement of debt is subject to the four-step decision sequence. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company has not yet adopted ASU 2016-06 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.
In February 2016, the FASB issued ASU 2016-02, "Leases" "(Topic 842)" ("ASU 2016-02"), which applies a right-of-use (ROU) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. ASU 2016-02 requires a lessor to classify leases as either sales-type, direct financing or operating, similar to existing U.S. GAAP requirements. Classification depends on the same five criteria used by lessees as well as certain additional factors. The new standard addresses other considerations including identification of a lease, separating lease and nonlease components of a contract, sale and leaseback transactions, modifications, combining contracts, reassessment of the lease term, and remeasurement of lease payments. Early adoption is permitted. The Company’s effective date for adoption is January 1, 2019. The Company has not yet adopted ASU 2016-02 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.
In January 2016, the FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities" "(Subtopic 825-10)" ("ASU 2016-01") which, among other things, requires all equity securities currently classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net income instead of accumulated other comprehensive income ("AOCI"). Certain provisions of ASU 2016-01 are eligible for early adoption. The Company’s effective date for adoption is January 1, 2018. The Company has not yet adopted ASU 2016-01 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.
3. Business Combinations
The Company’s acquisitions were accounted for using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date. Estimates of fair value included in the Condensed Consolidated Financial Statements, in conformity with ASC 820, “Fair Value Measurements and Disclosures”, represent the Company’s best estimates and valuations developed, when needed, with the assistance of independent appraisers or, where such valuations have not yet been completed or are not available, industry data and trends and by reference to relevant market rates and transactions. The following estimates and assumptions are inherently subject to significant uncertainties and contingencies beyond the control of the Company. Accordingly, the Company cannot provide assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially.
Any changes to the initial estimates of the fair value of the assets and liabilities will be recorded as adjustments to those assets and liabilities, and residual amounts will be allocated to goodwill. In accordance with ASC 805 “Business Combinations,” if additional information is obtained about the initial estimates of the fair value of the assets acquired and liabilities assumed within the measurement period (not to exceed one year from the date of acquisition), including finalization of asset appraisals, the Company will refine its estimates of fair value to allocate the purchase price more accurately.
Insurance Segment
On December 24, 2015, the Company completed the acquisitions of 100% of the interest in each of the Insurance Companies as well as all assets owned by the sellers of the Insurance Companies and their affiliates (the "Seller Parties") that are used exclusively or primarily in the business of the Insurance Companies, subject to certain exceptions. The operations of the Insurance Companies form the basis of our Insurance segment, and we plan to leverage their existing platform and industry expertise to identify strategic growth opportunities for managing closed blocks of long-term care businesses.
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HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The aggregate consideration paid in connection with the acquisition of the Insurance Companies and related transactions and agreements was valued at $18.7 million, consisting of $7.1 million of cash, $2.0 million in aggregate principal amount of the Company’s 11.0% Senior Secured Notes due 2019, 1,007,422 shares of the Company's common stock and five-year warrants to purchase 2,000,000 shares of the Company's common stock at an exercise price of $7.08 per share (subject to customary adjustments for stock splits or similar transactions) exercisable on or after February 3, 2016 (the "Warrants").
Purchase Price Allocation
The preliminary fair values of identified assets acquired, liabilities assumed, residual goodwill and consideration transferred are summarized as follows (in thousands):
Fair value of consideration transferred | ||||
Cash | $ | 7,146 | ||
Company’s Senior Secured Notes | 1,879 | |||
Company's common stock | 5,380 | |||
2016 Warrants | 4,332 | |||
Total fair value of consideration transferred | $ | 18,737 | ||
Purchase price allocation | ||||
Fixed maturities, available for sale at fair value | $ | 1,230,038 | ||
Equity securities, available for sale at fair value | 35,697 | |||
Mortgage loans | 1,252 | |||
Policy loans | 18,354 | |||
Other investments | 183 | |||
Cash and cash equivalents | 48,525 | |||
Recoverable from reinsurers | 522,790 | |||
Accrued investment income | 14,417 | |||
Goodwill | 46,613 | |||
Intangibles | 4,850 | |||
Other assets | 12,869 | |||
Total assets acquired | 1,935,588 | |||
Life, accident and health reserves | (1,592,722 | ) | ||
Annuity reserves | (259,675 | ) | ||
Value of business acquired | (51,584 | ) | ||
Deferred tax liability | (1,704 | ) | ||
Other liabilities | (11,166 | ) | ||
Total liabilities assumed | (1,916,851 | ) | ||
Total net assets acquired | $ | 18,737 |
The values of intangibles, life, accident and health reserves, annuity reserves, and value of business acquired are estimates and might change.
The acquisition of the Insurance Companies resulted in the recording of goodwill of approximately $46.6 million. Goodwill consists of the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. The Insurance Companies were recognized as a new stand-alone reporting unit. Goodwill is not amortized and is not deductible for tax purposes.
The Value of Business Acquired ("VOBA")
The VOBA was derived using a “Becker-ized” Present Value of Distributable Earnings (“PVDE”) method. The PVDE was derived using the statutory after tax profits. The VOBA was valued at $51.6 million and is amortized over the anticipated remaining
14
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
future lifetime of the acquired long-term care blocks of business. VOBA is amortized in relation to the projected future premium of the acquired long-term care blocks of business.
Recoverable from Reinsurers
The recoverable from reinsurers balance represents amounts recoverable from third parties. U.S. GAAP requires insurance reserves and recoverable from reinsurers balances to be presented on a gross basis, as opposed to U.S. statutory accounting principles, where reserves are presented net of reinsurance. Accordingly, the Company grossed up the fair value of the net insurance contract liability for the amount of reinsurance of approximately $515.9 million, to arrive at a gross insurance liability, and recognized an offsetting recoverable from reinsurers amount of approximately $515.9 million. As part of this process, management analyzed reinsurance counterparty credit risk and considers it to have an immaterial impact on the reinsurance fair value gross-up. To mitigate this risk substantially all reinsurance is ceded to companies with investment grade S&P ratings.
Amounts recoverable from reinsurers were estimated in a manner consistent with the liability associated with the reinsured policies and were an estimate of the recoverable from reinsurers amount in respect of each of paid and unpaid losses, including an estimate for losses incurred but not reported. Recoverable from reinsurers represents expected cash inflows from reinsurers for liabilities ceded and therefore incorporate uncertainties as to the timing and amount of claim payments. Recoverable from reinsurers includes the balances due from reinsurers under the terms of the reinsurance agreements for these ceded balances as well as settlement amounts currently due.
Contingent Liability
Pursuant to the agreements governing the acquisition of the Insurance Companies, the Company also agreed to pay to the Seller Parties, on an annual basis with respect to the years 2015 through 2019, the amount, if any, by which the Insurance Companies’ cash flow testing and premium deficiency reserves decrease from the amount of such reserves as of December 31, 2014. Such payments are capped at $13.0 million in the aggregate. The balance is calculated based on the fluctuation of the statutory cash flow testing and premium deficiency reserves annually following each of the Insurance Companies' filing with its applicable insurance regulator of its annual statutory financial statements for each calendar year ending December 31 through and including December 31, 2019. Based on the 2015 statutory statements, the Company does not have a payment due. Further, the Company's current estimate is that the obligation will not be incurred through the calendar year ending December 31, 2019. This expectation is primarily driven by the following factors: (i) reduced confidence that treasury rates will increase to historical averages over the near term; (ii) uncertainty around future operating expenses historically performed by the Seller Parties; and (iii) the increase in the premium deficiency reserve as reported at December 31, 2015 of approximately $8.0 million (because the balance is cumulative over the period, a decrease of approximately $8.0 million would be required before there would be any obligation to the Seller Parties under the earn-out). The Company will perform this assessment at each reporting period through December 31, 2019 or until the $13.0 million is paid in full.
Control Level Risk-Based Capital
In connection with the consummation of the acquisition of the Insurance Companies, the Company agreed with the statutory regulator of CGI, the Ohio Department of Insurance ("ODOI"), that for five years following the closing of the transaction, the Company will contribute to CGI cash or marketable securities acceptable to the ODOI to the extent required for CGI’s total adjusted capital to be not less than 400% of CGI’s authorized control level risk-based capital (each as defined under Ohio law and reported in CGI’s statutory statements filed with the ODOI). Similarly, the Company has agreed with the statutory regulator of UTA, the Texas Department of Insurance ("TDOI"), that, for five years following the closing of the transaction, the Company will contribute to UTA cash or other admitted assets acceptable to the TDOI to the extent required for UTA’s total adjusted capital to be not less than 400% of UTA’s authorized control level risk-based capital (each as defined under Texas law and reported in UTA’s statutory statements filed with the TDOI).
In connection with the consummation of the acquisition of the Insurance Companies, each of the Insurance Companies also entered into a capital maintenance agreement with Great American Financial Resources, Inc. ("GAFRI" and each such agreement, a “Capital Maintenance Agreement,” and collectively, the “Capital Maintenance Agreements”). Under each Capital Maintenance Agreement, if the applicable Insurance Company's total adjusted capital reported in its annual statutory financial statements is less than 400% of its authorized control level risk-based capital, GAFRI will pay cash or assets to the applicable Insurance Company, as required, to eliminate such shortfall (after giving effect to any capital contributions made by the Company or its affiliates since the date of the relevant annual statutory financial statements). GAFRI’s obligation to make such payments is capped at $25.0
15
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
million under the Capital Maintenance Agreement with UTA and $10.0 million under the Capital Maintenance Agreement with CGI. Each of the Capital Maintenance Agreements will remain in effect from January 1, 2016 to January 1, 2021, or until payments by GAFRI thereunder equal the maximum amount payable under the applicable agreement. The Company will indemnify GAFRI for the amount of any payments made by it under the Capital Maintenance Agreements.
Other
Transaction costs incurred in connection with the acquisition of the Insurance Companies were $0.0 and $0.5 million during the three and nine months ended September 30, 2016 and were included within Selling, general and administrative expenses. The Company recorded net revenue of $34.5 million and $99.8 million and net loss of $2.0 million and $12.6 million from the Insurance Companies for the three and nine months ended September 30, 2016.
Pro Forma Adjusted Summary
The results of operations for the Insurance Companies have been included in the Condensed Consolidated Financial Statements subsequent to their acquisition date.
The following schedule presents unaudited consolidated pro forma results of operations data as if the acquisition of the Insurance Companies had occurred on January 1, 2015. This information neither purports to be indicative of the actual results that would have occurred if those acquisitions had actually been completed on the date indicated, nor is it necessarily indicative of the future operating results or the financial position of the combined company (in thousands, except per share amounts):
Three Months Ended September 30, 2015 | Nine Months Ended September 30, 2015 | |||||||
Net revenue | $ | 315,371 | $ | 876,697 | ||||
Net loss from continuing operations | $ | (7,119 | ) | $ | (22,451 | ) | ||
Loss from discontinued operations | (24 | ) | (44 | ) | ||||
Net loss attributable to HC2 | $ | (7,143 | ) | $ | (22,495 | ) | ||
Per share amounts: | ||||||||
Loss from continuing operations | $ | (0.28 | ) | $ | (0.89 | ) | ||
Loss from discontinued operations | $ | — | $ | — | ||||
Net loss attributable to HC2 | $ | (0.28 | ) | $ | (0.90 | ) |
Other Acquisitions
During the nine months ended September 30, 2016, we purchased three fueling stations, completed the acquisition of additional interests in and thereby control of NerVve and BeneVir, and acquired a 60% controlling interest in CWind Limited ("CWind") with an obligation to purchase the remaining 40% in equal amounts on September 30, 2016 and September 30, 2017 (based on agreed financial targets). The total consideration transferred for these acquisitions was $21.9 million including $13.7 million in cash. The results of each of the companies acquired have been reported in our results of operations from the date of acquisition.
We have preliminarily allocated the purchase price of these acquired businesses to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. We are in the process of completing the valuation of identifiable intangible assets, fixed assets and debt; therefore, the fair values set forth below are subject to adjustment upon finalization of the valuations. The amounts in respect of these potential adjustments could be significant. We expect to complete the purchase price allocation for fiscal year 2016 acquisitions during fiscal year 2017.
The following table summarizes the preliminary allocation of the purchase price to the fair value of identifiable assets acquired and liabilities assumed for the fiscal year 2016 acquisitions at the date of acquisition, in accordance with the acquisition method of accounting:
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HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Total | ||||
Consideration | ||||
Cash | $ | 13,671 | ||
Convertible notes | 2,915 | |||
Promissory note | 1,128 | |||
Fair value of previously held interest | 4,610 | |||
Contingent asset | (2,992 | ) | ||
Deferred consideration | 2,589 | |||
Total fair value of consideration transferred | $ | 21,921 | ||
Purchase price allocation | ||||
Cash and cash equivalents | $ | 2,966 | ||
Accounts receivable | 6,400 | |||
Inventory | 528 | |||
Property, plant and equipment, net | 32,439 | |||
Goodwill | 7,242 | |||
Intangibles | 12,557 | |||
Other assets | 2,335 | |||
Total assets acquired | 64,467 | |||
Accounts payable and other current liabilities | (11,180 | ) | ||
Deferred tax liability | (5,494 | ) | ||
Long-term obligations | (20,813 | ) | ||
Other liabilities | (15 | ) | ||
Noncontrolling interest | (815 | ) | ||
Total liabilities assumed | (38,317 | ) | ||
Enterprise value | 26,150 | |||
Less fair value of noncontrolling interest | 3,889 | |||
Bargain purchase gain | 340 | |||
Purchase price attributable to controlling interest | $ | 21,921 |
4. Investments
Fixed Maturity and Equity Securities Available-for-Sale
The following tables provide information relating to investments in fixed maturity and equity securities as of September 30, 2016 and December 31, 2015 (in thousands):
September 30, 2016 | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
Fixed maturity securities | ||||||||||||||||
U.S. Government and government agencies | $ | 16,081 | $ | 834 | $ | — | $ | 16,915 | ||||||||
States, municipalities and political subdivisions | 375,661 | 25,988 | (36 | ) | 401,613 | |||||||||||
Foreign government | 6,392 | — | (113 | ) | 6,279 | |||||||||||
Residential mortgage-backed securities | 141,837 | 2,192 | (550 | ) | 143,479 | |||||||||||
Commercial mortgage-backed securities | 59,114 | 1,113 | (78 | ) | 60,149 | |||||||||||
Asset-backed securities | 68,865 | 1,912 | (261 | ) | 70,516 | |||||||||||
Corporate and other | 587,499 | 48,194 | (2,967 | ) | 632,726 | |||||||||||
Total fixed maturity securities | $ | 1,255,449 | $ | 80,233 | $ | (4,005 | ) | $ | 1,331,677 | |||||||
Equity securities | ||||||||||||||||
Common stocks | $ | 17,485 | $ | 2,402 | $ | (393 | ) | $ | 19,494 | |||||||
Perpetual preferred stocks | 36,752 | 734 | (474 | ) | 37,012 | |||||||||||
Total equity securities | $ | 54,237 | $ | 3,136 | $ | (867 | ) | $ | 56,506 |
17
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
December 31, 2015 | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
Fixed maturity securities | ||||||||||||||||
U.S. Government and government agencies | $ | 17,131 | $ | 1 | $ | (49 | ) | $ | 17,083 | |||||||
States, municipalities and political subdivisions | 387,427 | 60 | (1,227 | ) | 386,260 | |||||||||||
Foreign government | 6,426 | 3 | — | 6,429 | ||||||||||||
Residential mortgage-backed securities | 166,324 | 579 | (588 | ) | 166,315 | |||||||||||
Commercial mortgage-backed securities | 74,898 | 233 | (96 | ) | 75,035 | |||||||||||
Asset-backed securities | 34,396 | 106 | (51 | ) | 34,451 | |||||||||||
Corporate and other | 553,487 | 318 | (7,537 | ) | 546,268 | |||||||||||
Total fixed maturity securities | $ | 1,240,089 | $ | 1,300 | $ | (9,548 | ) | $ | 1,231,841 | |||||||
Equity securities | ||||||||||||||||
Common stocks | $ | 19,935 | $ | 1 | $ | (1,311 | ) | $ | 18,625 | |||||||
Perpetual preferred stocks | 30,901 | 162 | (6 | ) | 31,057 | |||||||||||
Total equity securities | $ | 50,836 | $ | 163 | $ | (1,317 | ) | $ | 49,682 |
The Company has investments in mortgage-backed securities ("MBS") that contain embedded derivatives (primarily interest-only MBS) that do not qualify for hedge accounting. The Company recorded the change in the fair value of these securities within Net realized losses on investments. These investments had a fair value of $15.0 million and $21.0 million as of September 30, 2016 and December 31, 2015, respectively. The change in fair value related to these securities resulted in a net loss of approximately $0.1 million and $2.4 million for the three and nine months ended September 30, 2016, respectively, and $0 for each of the three and nine months ended September 30, 2015.
Maturities of Fixed Maturity Securities Available-for-Sale
The amortized cost and fair value of fixed maturity securities available-for-sale as of September 30, 2016 are shown by contractual maturity in the table below (in thousands). Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset and mortgage-backed securities are shown separately in the table below, as they are not due at a single maturity date:
Amortized | Fair | |||||||
Cost | Value | |||||||
Corporate, Municipal, U.S. Government and Other securities | ||||||||
Due in one year or less | $ | 40,777 | $ | 38,312 | ||||
Due after one year through five years | 115,932 | 120,562 | ||||||
Due after five years through ten years | 141,642 | 148,033 | ||||||
Due after ten years | 687,282 | 750,626 | ||||||
Subtotal | 985,633 | 1,057,533 | ||||||
Mortgage-backed securities | 200,951 | 203,628 | ||||||
Asset-backed securities | 68,865 | 70,516 | ||||||
Total | $ | 1,255,449 | $ | 1,331,677 |
Corporate Fixed Maturity Securities
The tables below show the major industry types of the Company’s corporate and other fixed maturity securities as of September 30, 2016 and December 31, 2015 (in thousands):
18
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2016 | December 31, 2015 | |||||||||||||||||||||
Amortized | Fair | % of | Amortized | Fair | % of | |||||||||||||||||
Cost | Value | Total | Cost | Value | Total | |||||||||||||||||
Finance, insurance, and real estate | $ | 210,441 | $ | 216,550 | 34.2 | % | $ | 223,144 | $ | 217,377 | 39.8 | % | ||||||||||
Transportation, communication and other services | 166,645 | 181,405 | 28.7 | % | 156,022 | 155,175 | 28.4 | % | ||||||||||||||
Manufacturing | 118,492 | 129,738 | 20.5 | % | 95,138 | 94,792 | 17.4 | % | ||||||||||||||
Other | 91,921 | 105,033 | 16.6 | % | 79,183 | 78,924 | 14.4 | % | ||||||||||||||
Total | $ | 587,499 | $ | 632,726 | 100.0 | % | $ | 553,487 | $ | 546,268 | 100.0 | % |
Other-Than-Temporary Impairments - Fixed Maturity and Equity Securities
A portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities is recognized in AOCI. For these securities the net amount recognized in the Condensed Consolidated Statements of Operations (“credit loss impairments”) represents the difference between the amortized cost of the securities and the net present value of their projected future cash flows discounted at the effective interest rate implicit in such securities prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The Company recorded a $1.5 million and $2.6 million impairment related to two fixed maturity securities for the three and nine months ended September 30, 2016, respectively. The Company reported a $2.5 million impairment within Other income (expense), net and a $0.2 million impairment within Net realized losses on investments. The Company did not record any impairments on fixed maturity or equity securities during the three and nine months ended September 30, 2015.
Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale
The following table presents the total unrealized losses for the 117 and 528 fixed maturity and equity securities held by the Company as of September 30, 2016 and December 31, 2015, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (in thousands):
September 30, 2016 | December 31, 2015 | |||||||||||||
Unrealized | % of | Unrealized | % of | |||||||||||
Losses | Total | Losses | Total | |||||||||||
Fixed maturity and equity securities | ||||||||||||||
Less than 20% | $ | (1,965 | ) | 40.3 | % | $ | (5,667 | ) | 52.2 | % | ||||
20% or more for less than six months | (337 | ) | 6.9 | % | — | — | % | |||||||
20% or more for six months or greater | (2,570 | ) | 52.8 | % | (5,198 | ) | 47.8 | % | ||||||
Total | $ | (4,872 | ) | 100.0 | % | $ | (10,865 | ) | 100.0 | % |
The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include (i) whether the unrealized loss is credit-driven or a result of changes in market interest rates, (ii) the extent to which fair value is less than cost basis, (iii) cash flow projections received from independent sources, (iv) historical operating, balance sheet and cash flow data contained in issuer SEC filings and news releases, (v) near-term prospects for improvement in the issuer and/or its industry, (vi) third party research and communications with industry specialists, (vii) financial models and forecasts, (viii) the continuity of dividend payments, maintenance of investment grade ratings and hybrid nature of certain investments, (ix) discussions with issuer management, and (x) ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value.
The Company analyzes its MBS for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan-to-collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data.
The Company believes it will recover its cost basis in the non-impaired securities with unrealized losses and that the Company has the ability to hold the securities until they recover in value. The Company neither intends to sell nor does it expect to be required to sell the securities with unrealized losses as of September 30, 2016 and December 31, 2015, respectively. However, unforeseen
19
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
facts and circumstances may cause the Company to sell fixed maturity and equity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines.
The following tables present the estimated fair values and gross unrealized losses for the 117 and 528 fixed maturity and equity securities held by the Company that have estimated fair values below amortized cost as of September 30, 2016 and December 31, 2015, respectively. The Company does not have any OTTI losses reported in AOCI. These investments are presented by investment category and the length of time the related fair value has remained below amortized cost (in thousands):
September 30, 2016 | Less than 12 months | 12 months of greater | Total | |||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
Fixed maturity securities | ||||||||||||||||||||||||
U.S. Government and government agencies | $ | 131 | $ | — | $ | — | $ | — | $ | 131 | $ | — | ||||||||||||
States, municipalities and political subdivisions | 7,080 | (36 | ) | — | — | 7,080 | (36 | ) | ||||||||||||||||
Foreign government | 6,279 | (113 | ) | — | — | 6,279 | (113 | ) | ||||||||||||||||
Residential mortgage-backed securities | 47,909 | (550 | ) | — | — | 47,909 | (550 | ) | ||||||||||||||||
Commercial mortgage-backed securities | 10,703 | (78 | ) | — | — | 10,703 | (78 | ) | ||||||||||||||||
Asset-backed securities | 17,939 | (261 | ) | — | — | 17,939 | (261 | ) | ||||||||||||||||
Corporate and other | 40,389 | (396 | ) | 5,040 | (2,571 | ) | 45,429 | (2,967 | ) | |||||||||||||||
Total fixed maturity securities | $ | 130,430 | $ | (1,434 | ) | $ | 5,040 | $ | (2,571 | ) | $ | 135,470 | $ | (4,005 | ) | |||||||||
Equity securities | ||||||||||||||||||||||||
Common stocks | $ | 5,515 | $ | (393 | ) | $ | — | $ | — | $ | 5,515 | $ | (393 | ) | ||||||||||
Perpetual preferred stocks | 11,520 | (474 | ) | — | — | 11,520 | (474 | ) | ||||||||||||||||
Total equity securities | $ | 17,035 | $ | (867 | ) | $ | — | $ | — | $ | 17,035 | $ | (867 | ) |
December 31, 2015 | Less than 12 months | 12 months of greater | Total | |||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Losses | Value | Losses |